Investing for the long term

Why you should invest over longer periods and what to look out for

Article updated: 10 January 2020 2:00pm Author: Ian Forrest

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At times of great political and economic uncertainty it is easy for investors to be influenced by the latest trading update from companies, especially if they fall short in terms of sales growth or profits. In those circumstances, and among the heightened market tension with big swings in share prices taking place, it is possible to lose sight of the bigger picture.

While it is naturally wise to keep an eye on current trading, investors should try to remember that historically the best returns come from investing over longer periods of five years plus. As a result symmetry is achieved when investors with long term timescales put their money into companies which are managed carefully, with a view to growing sustainably over decades.

In that context small fluctuations in quarterly sales growth should not in themselves be seen as overly significant. The large, long term investors in the market, including pension funds and insurance companies, tend not to dwell so much on those because they appreciate that creating value for shareholders is about building a sustainable and profitable business over a period of time.
That sounds simple enough, but is actually not that straightforward. It usually relies on growth, ideally organically, although some companies can achieve it through well-timed acquisitions made at a sensible price.

The long-running low interest rate environment and market volatility has led many investors to seek out larger, more stable companies with good dividends. But what are the key signs to look for? And how are companies managed for the long term with shareholders’ interests at their heart?

Creating value takes time

There are a number of indicators that investors should look out for which strongly suggest that a company is being managed with the long term in mind.

First and foremost, company management must be ready to adapt their strategy when circumstances change. Events at supermarket giant Tesco provide a good recent example of this. The management there realised that they needed to make significant changes to the company in order to address a number of internal and external issues affecting the company. Dave Lewis arrived as chief executive and set about implementing a new strategy which involved making difficult decisions, such as selling non-core assets which had been built up by previous executives. That policy took several years but has ultimately proved successful.

Maintaining a sustainable level of debt over the long term is another sign that a company is well managed. It sounds obvious but it is amazing how many companies allow their debts to rise rapidly, perhaps because of a series of rash acquisitions, which can lead to previously stated borrowing limits being broken and a passage into stormy waters from which some do not return.

A steady amount of cash flow is another figure to look for as it provides the management with options, either to invest in growing the company, or paying dividends. If the latter are covered at least twice by earnings and rise at least in line with inflation that is another strong indicator that the finances are under control and the interests of shareholders are important to the management. A dividend policy that still provides room for occasional share buybacks is also a positive point as not all investors want a cash return.

Of course, good dividends by themselves are not a good indicator, as former investors in Carillion will attest. The failure of that company in 2018 reminded us that investors should keep an eye on a number of factors, including profit margins and debt levels, rather than rely purely on one in particular. Allegations that the company’s accounts were not as transparent as they could have been also remind us of the need to accept that investing sometimes carries risks that are not always visible and so we should be careful to limit our exposure to individual companies.

Companies where one or two individual executives appear to dictate everything, even down to fairly minor decisions, are also a warning sign. Good corporate governance seeks to prevent that and tries to ensure that senior execs have time to implement their strategy, handovers are done in an orderly way and independent non-execs have a key role in decision-making.
Investors also need to bear in mind that external factors, such as increased state regulation and new taxes, can play a big part in determining the success of their investment, and even the best management can struggle to maintain growth, but the points mentioned above provide a good start for investors in determining whether company management is likely to create long-term value.

A good approach for investors looking to follow a long-term approach is to invest steadily over time rather than all in one lump sum at the start. This is called drip-feeding and helps to smooth out the regular rises and falls in the market. It can be achieved in a variety of ways, such as splitting an investment into two or three smaller transactions over the course of a year, or perhaps by setting up a regular monthly investment plan.


All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.

 

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Ian Forrest

Investment Research Analyst

Ian’s background in investments, financial journalism and research has seen him advising private investors on equities and helping to manage portfolios. His qualifications include the Certificate in Financial Planning and the Chartered Institute for Securities & Investment’s Investment Advice Diploma.

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